Living Economics

Domestic inflation in China as well as yuan appreciation have boosted the prices of Chinese imports to the US.

The prices of shoes, furniture and luggage imported from China increased more than 6% in 2011 from a year earlier. This price increase is a direct result of rapid rise in labor costs in China, in the range of 20% to 30%. Many provinces and municipalities in China have ushered in annual minimum wage increases of 22% by October 2011(WSJ 12/15/2011).

Rapid economic development and dwindling supply of young migrant workers has finally pushed up wages in China. And together with a 24% rise in the yuan exchange value against the US dollar since 2005, the real exchange value of the yuan has gone up some 50% (Economist 11/6/2011).

China's effort to stimulate domestic demand in the wake of the Great Recession has also unleashed domestic inflation and a housing bubble.

So it appears that China has behaved more or less the way a country on a textbook Gold Standard should behave. That is, a country with a trade surplus under a fixed exchange rate regime should let its domestic prices go up to make its exports less competitive. But China has incessantly been labeled as a "currency manipulator" because it has not allowed its yuan to appreciate more. It seems that some critics have conveniently forgotten how a Gold Standard should work. If China prefers to more or less peg its yuan to the US dollar and adjust its domestic prices instead in the face of trade surpluses, it should be free to do so without incurring puzzling criticism (WSJ. 8/20/2011).

Surely, a 100% appreciation of the yuan against the US dollar would obliterate China's trade surplus overnight. But it still does not resolve the long-standing structural issues that have led to its chronic trade surplus. And it certainly would not eliminate US's trade deficit. Instead, it would simply shift its trade deficits to other low-wage exporting countries over time.

It is not clear how eliminating US trade deficits with China could help reduce US's chronic budget deficits that are over-burdened with unaffordable entitlements and raise its low saving rate. China could of course be faulted for not inflating its economy more with the foreign exchanges it earns from net exports. But its hoarding of foreign reserves to buy US Treasuries is an important reason why the Fed can print money at will without raising its interest rates?